Paul Kupiec and Alex Pollock have an op-ed in the Wall Street Journal arguing for a pair of federal government interventions in the mortgage market to boost the volume of residential real estate transactions that has been depressed because of borrowers being locked into very low rate mortgages and large, taxable appreciation. Alas, these interventions won’t work, as explained below the break. 

First, Kuliec and Pollock would seek to make mortgages assumable by buyers by having Congress override due-on-sale clauses with a defeasement account system (like in some corporate bonds) created to protect lenders from credit risk by having some settlement proceeds put into an escrow account invested in Treasuries. The seller would get the same proceeds (or even more, depending on Treasury rates). The buyer would take over the low rate mortgage, and the lender would get collateral of Treasuries, even better than (and in addition to) the house.  

Second, they would have the capital gains tax exclusion for sales of primary residences become inflation adjusted retrospectively, so much less gains would be taxable. The result would be that sellers pay lower taxes.

I see a few problems here. First, what has happened to American conservativism? Are bailouts now part of the conservative program? Since when do AEI and Mises types argue for government intervention in markets to benefit, well, who exactly? Builders, realtors, and well-off existing borrowers with lots of appreciation.

Let’s set that philosophical stuff aside, though, and focus on the cui bono. Kupiec and Pollock believe that they will help borrowers (and make no mention of builders or realtors), but is that reasonable? First, these are well-off borrowers: they own homes with substantial equity gains. Not exactly the needy. Moreover,  borrowers and lenders should both have known of the lock in risk with 3% loans. This was a train wreck anyone could see miles off.

New homebuyers are the most sympathetic party here, but Kupiec and Pollock’s solution isn’t targeted to help just them. Instead, it seeks to bail out the whole market. That’s overbroad, even if one thinks it is the government’s role to deal with a stagnant home market. Government intervention is reasonable when there is a market failure, but a stagnant market is NOT a market failure as far as I know. 

Second, all this proposal will do is push up home prices. It has the effect of lowering mortgage rates for a subset of properties, which will of course result in prices being bid up…resulting in larger gains in sale. There’s no affordability fix here. So who actually benefits? Just builders and realtors, not borrowers or would-be buyers.

Third, contrary to Kupiec and Pollock’s breezy claim, there’s an enormous uncompensated taking here. Kupiec and Pollock claim that there’s been no increase in credit risk, so no _uncompensated_ taking. Maybe (but they should learn about “indubitable equivalence” in bankruptcy jurisprudence). But there’s a HUGE impact on rate risk. Their proposal would result in almost every 30y fixed mortgage (i.e., almost all of the market) paying out to full maturity, depriving lenders of the ability to relend in a higher rate environment. That’s likely a massive and uncompensated taking.

Kupiec and Pollock would likely respond by saying that the lender always had the risk of the borrower paying over 30 years, which is true, but it was always subject to the borrower continuing to own the property. The lender has been deprived of that valuable contractual condition, and that should be enough for a taking. But it hardly matters if I’m right on the legal analysis. It’s enough that I might be. The litigation risk alone will make this proposal a non-starter, our dysfunctional, necrotic Congress aside.